KB Home — Q3 2011 Form 10-Q
Reporting period: Three and nine months ended August 31, 2011; balance-sheet comparisons are with November 30, 2010. Amounts below are in millions unless noted.
Business context
KB Home builds and sells homes through four U.S. homebuilding segments—West Coast, Southwest, Central and Southeast—and provides title and insurance services. The company described housing conditions as difficult, citing excess resale and foreclosed-home supply, weak employment and consumer confidence, tight mortgage credit, and intense competition. It continued investing in land and communities, with emphasis on California and Texas.
Financial and operating results
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Total revenue | $367.3 | $501.0 | $836.0 | $1,139.0 |
| Homebuilding revenue | $364.5 | $498.8 | $829.8 | $1,133.8 |
| Operating income (loss), homebuilding | $1.4 | $8.4 | $(103.9) | $(45.1) |
| Net loss | $(9.6) | $(1.4) | $(192.7) | $(86.8) |
| Loss per share | $(0.13) | $(0.02) | $(2.50) | $(1.13) |
| Homes delivered | 1,603 | 2,320 | 3,817 | 5,428 |
| Average selling price | $227,400 | $214,200 | $217,400 | $208,100 |
| Housing gross margin | 16.9% | 17.5% | 12.7% | 16.7% |
| SG&A as % of housing revenue | 16.5% | 15.8% | 20.8% | 20.7% |
Q3 housing revenue fell 27% year over year, mainly because deliveries declined 31%, partly offset by a 6% increase in average selling price. The company’s non-GAAP housing gross margin excluding inventory impairment and land-option abandonment charges was 17.2% in Q3 versus 18.2% a year earlier, but improved sequentially from 13.4% in Q1 and 14.9% in Q2. The reported Q3 margin included $7.4 million of favorable warranty adjustments. For the nine-month period, the comparable adjusted margin was 15.6%, down from 18.2%.
Financial services generated pretax income of $1.1 million in Q3 and $3.3 million for nine months, versus $2.4 million and $8.5 million in the comparable 2010 periods. KBA Mortgage stopped taking applications in June following Bank of America’s decision to exit the joint venture; KB Home began a marketing-services arrangement with MetLife Home Loans.
Cash flow, debt and liquidity
- Cash and cash equivalents were $477.4 million and restricted cash was $113.2 million at August 31, 2011, or $590.6 million combined, down from $1,019.9 million combined at November 30, 2010.
- Operating activities used $309.9 million in the first nine months, compared with $164.1 million used in 2010. Investing activities provided $78.6 million, including $80.6 million from a property sale. Financing activities used $196.8 million.
- Debt was $1.587 billion, down from $1.776 billion, following repayment of $100 million of notes at maturity and repayment of secured debt. Debt-to-total-capital rose to 78.6% from 73.8%; net-debt-to-total-capital rose to 69.8% from 54.5%.
- Stockholders’ equity fell to $432.0 million from $631.9 million. The company reported compliance with debt covenants and no financial maintenance covenants in its senior-note indenture.
Material changes and unusual items
- Net orders increased 40% year over year to 1,838 in Q3; backlog rose 22% to 2,657 homes, with projected revenue of $559.3 million. The cancellation rate improved to 29% from 33%.
- Nine-month results included a $53.7 million noncash write-off of the South Edge joint-venture investment, a $37.3 million loss on a South Edge loan guaranty, and $23.5 million of inventory impairment and land-option abandonment charges. The South Edge charge and impairment were major contributors to the larger year-over-year loss.
- Inventory impairment and land-option abandonment charges were $1.2 million in Q3, versus $3.4 million a year earlier. Warranty adjustments reduced Q3 construction and land costs by approximately $7.4 million.
- Deferred-tax valuation allowance increased by $73.3 million during the first nine months to $844.4 million; net deferred tax assets were $1.1 million. The filing says effective tax rates are not meaningful because of valuation allowances, NOL carrybacks and changes in unrecognized tax benefits.
- On September 20, 2011, after quarter-end, KB Home filed an automatically effective shelf registration for possible debt and equity offerings. The company said it had no plan to issue equity.
Outlook, risks and contingencies
Management expected Q4 net orders, deliveries, average selling price, revenue and housing gross margin to increase sequentially, with SG&A as a share of housing revenue to decrease. It expected Q4 profitability if housing markets remained near then-current activity levels, but did not expect a profit for full-year 2011. Management forecast approximately $550 million of full-year 2011 land and land-development investment, after approximately $409 million in the first nine months, and about 20 additional community openings in Q4. It expected year-end cash and restricted cash to exceed $500 million after anticipated operating needs, including the South Edge payment if made by November 30.
The South Edge bankruptcy plan remained uncertain. KB Home estimated its probable net payment obligation at $226.4 million, potentially as high as $240 million, and had deposited $21.4 million in escrow. The plan contemplated acquiring a substantial share of South Edge land; if the company cannot realize the estimated value of its share, it could incur additional expense of up to $75 million. Separately, a pending appeal concerns an arbitration award; the company recorded a $25.5 million accrual for its estimated maximum share. The company also reported construction-defect and other litigation liabilities, warranty exposure, and outstanding performance bonds and letters of credit.
Management warned that weaker housing markets could prompt further inventory or joint-venture impairments and land-option abandonment charges, reduce planned land investment and community openings, and pressure liquidity and profitability. Other stated risks include foreclosures and short sales, mortgage-credit availability, employment and consumer confidence, competition, construction costs, and the outcomes of South Edge proceedings. Management considered the carrying value of inventory recoverable but emphasized the sensitivity of impairment estimates to assumptions and market conditions.
Important facts for investors to verify
- Whether the South Edge plan was confirmed and implemented, the final payment obligation, and the recoverable value of the land.
- Whether Q4 profitability and the stated sequential operating improvements materialized, and how orders, cancellations, deliveries and backlog developed.
- Cash and restricted-cash levels after the South Edge payment and planned land investment, alongside operating cash use and debt maturities.
- Whether housing margins and inventory valuations held up without relying on favorable warranty adjustments or optimistic market assumptions.
- Developments in the arbitration appeal, construction-defect litigation, warranty claims and contingent guarantees.